A Brief Guide to Mutual Funds

A mutual fund is a joint stock that is managed for and by the investors who buy into the fund. Such mutual funds allow the investors to benefit from a diversified investment portfolio, without him/her having to actually invest a large sum of money.

A diversified investment portfolio has many advantages. For starters, it protects the investor against rapid market losses if any one particular stock plummets downwards. Consider an investor who has as many as twenty stocks. In such a case, if one of the stocks loses its value, then the loss would be just of one stock among many. Hence the total value of the loss is felt less.

Though diversification of portfolio is a very good investment idea, it is not always possible for small investors to put in so much money. This is where mutual funds help such investors to get the benefits of a diverse portfolio with only a small investment.

Mutual funds do include stocks, but in addition they can also contain other kinds of holdings such as bonds and market instruments. In the real sense of the term, mutual funds are a company and people who are investing in mutual funds are in a way buying the shares of that company. Such shares are directly bought from the fund or by brokers who are acting for that fund. When the mutual bonds are sold back to the fund, the shares are redeemed.

Investment professionals who decide the type of securities to include in the fund generally manage such funds. These funds are rated by an index such as the Dow Jones Industrial Average. The mutual bonds simply duplicate the fluctuations on these holdings.

Mutual funds carry their risks. Investors are needed to pay some charges irrespective of the manner in which the fund performs. The investor would also not have any consensus in what kinds of securities are included in the fund. There is no accuracy about the actual value of the mutual fund share, as is present in the stock market.

However, the plus points are that mutual funds could be the best investment plans for the small investors, who might not have the capital to invest in stocks or bonds. Mutual funds provide a buffer effect in case some stocks lose, by creating a diverse portfolio. But, it is necessary to point out and understand that mutual funds would also lose their value over time. Hence it is more advisable to go in for a short term investment so that there is a rate of return.

The three types of mutual funds prevalent in the investment market are the money market funds, bond funds and the stock funds. Out of these the money market funds are the safest as they contain purely of high quality investments issued by the US government itself and by the blue chip corporations. However, the downside to them is that they pay a low rate of return.

Bond funds carry risks associated with companies going bankrupt and falling interest rates. For this reason, they also pay better as investments.

Stock funds are the riskiest. Short-term investors could feel the brunt more than long-term investors. But the investment is most profitable with stock funds, so much so, that such funds have generally outperformed all other kinds of investments over long periods of time.

Growth funds are a type of stock funds. These can maximize the capital gain and income funds that focus only on stocks and perform regularly by paying dividends.

In short, mutual funds could be wise investments only if people have a fair deal of experience with investments. It does not matter if the investment is small, but it is necessary to choose the right kind of fund. This enables the investor to calculate how much risk he/she is willing to take with the investment.